A value added statement (VAS) is a statement showing the net added value of a business firm during a certain period on its total transaction. The main purpose of value added statement (VAS) is to ascertain how much of the total net value was added and how it was distributed to the contributors of the value. Therefore, a value added statement (VAS) is regarded as a part of social responsibility accounting. A value added statement shows the wealth or value created and attributed to all stakeholders rather than just the shareholders. While the income statement reports on the income of shareholders, the value added statement(VAS) reports on the income earned by a large group of stakeholders, all the providers of capital plus employees and the government.
Advantages Of Value Engineering
The following are the advantages of value engineering:
* Value engineering helps achieve an improved product design and quality.
* Value engineering suggests eliminating the unnecessary functions in the organization that increase costs and have complex ties.
* Value engineering enhances the customers' satisfaction and sales by determining the exact need and expectation of customers.
* Value engineering emphasizes on seeking the alternatives for achieving the function and on applying the best alternative among the various courses of actions available.
* Value engineering provides competitive advantages to the firm in the areas of product quality, costs and customer's satisfaction.
* Value engineering focuses on standardization of the parts and components by identifying the possibility of using the same component or function in different products of the company. This brings economy in the cost of manufacturing the parts and components.
* Value engineering helps achieve an improved product design and quality.
* Value engineering suggests eliminating the unnecessary functions in the organization that increase costs and have complex ties.
* Value engineering enhances the customers' satisfaction and sales by determining the exact need and expectation of customers.
* Value engineering emphasizes on seeking the alternatives for achieving the function and on applying the best alternative among the various courses of actions available.
* Value engineering provides competitive advantages to the firm in the areas of product quality, costs and customer's satisfaction.
* Value engineering focuses on standardization of the parts and components by identifying the possibility of using the same component or function in different products of the company. This brings economy in the cost of manufacturing the parts and components.
Measurement Of Value In Value Engineering
Value engineering measures the price cost ratio for each function of the product. Value is, in fact, utility or the level of satisfaction to be acquired from a product.
Value = Price Of The Function/Cost Of The Function
Price of the function is expected price for that particular function which the customers are ready to pay. Cost of the function is the expected expenses to be made by the company to achieve that function. It is obvious that price must exceed cost; therefore value should be greater than one. The higher the value,the higher will be the contribution of the function towards the product's profitability.
Value = Price Of The Function/Cost Of The Function
Price of the function is expected price for that particular function which the customers are ready to pay. Cost of the function is the expected expenses to be made by the company to achieve that function. It is obvious that price must exceed cost; therefore value should be greater than one. The higher the value,the higher will be the contribution of the function towards the product's profitability.
Concept And Meaning Of Value Engineering And Its Process And Areas
Value engineering is also known as value analysis. Value engineering is a systematic examination of factors affecting the cost of a product or a service in order to devise means of achieving the specified purpose at the required standard of quality and reliability of the target cost. The main aim of value engineering is to achieve a product's target cost,by:
* Identifying improved product designs that reduce the product's cost without sacrificing its functionality
* Eliminating unnecessary functions that increase the cost of product.
Value engineering requires the use of functional analysis. This process involves segregating a product into its many elements. For example, in the case of automobiles, the function might consist of style, comfort, performance,reliability, quality, attractiveness and other aspects. A price or a value for each element is determined, which reflects the amount the customer is willing to pay for the product. To obtain this information, companies normally conduct surveys and interviews with customers. The total of the values for each function gives the estimated selling price from which the target profit is deducted to derive the target cost.The cost of each function of a product is compared with the benefits perceived by the customers. If the cost of the function exceeds the benefits to the customer,then the function should be eliminated, modified to reduce its cost, or enhanced in terms of its perceived value so that its value exceeds the cost.
Therefore, value engineering is the technique applied to analyze all the aspects of an existing product or component to determine the minimum cost necessary for specific functional requirements.
Process Of Value Engineering
1. Functional Analysis
2. Standardization Of Components And Parts
3. Alternatives Of Functions
4. Value-cost Analysis
5. Re-engineering
Areas Of Value Engineering
1. Improvements in product designs
2. Changes in materials' specifications
3. Modification in process methods
4. Decision to make or buy a component
* Identifying improved product designs that reduce the product's cost without sacrificing its functionality
* Eliminating unnecessary functions that increase the cost of product.
Value engineering requires the use of functional analysis. This process involves segregating a product into its many elements. For example, in the case of automobiles, the function might consist of style, comfort, performance,reliability, quality, attractiveness and other aspects. A price or a value for each element is determined, which reflects the amount the customer is willing to pay for the product. To obtain this information, companies normally conduct surveys and interviews with customers. The total of the values for each function gives the estimated selling price from which the target profit is deducted to derive the target cost.The cost of each function of a product is compared with the benefits perceived by the customers. If the cost of the function exceeds the benefits to the customer,then the function should be eliminated, modified to reduce its cost, or enhanced in terms of its perceived value so that its value exceeds the cost.
Therefore, value engineering is the technique applied to analyze all the aspects of an existing product or component to determine the minimum cost necessary for specific functional requirements.
Process Of Value Engineering
1. Functional Analysis
2. Standardization Of Components And Parts
3. Alternatives Of Functions
4. Value-cost Analysis
5. Re-engineering
Areas Of Value Engineering
1. Improvements in product designs
2. Changes in materials' specifications
3. Modification in process methods
4. Decision to make or buy a component
Tools And Techniques Of Cost Reduction
The following are the widely used techniques of cost reduction:
1. Just-In-Time (JIT) System
The main aim of JIT is to produce the required items, at the required quality and quantity, at the precise time they are required. JIT purchasing requires for the items where too much carrying costs associated with holding high inventory levels. purchasing system reduces the investment in inventories because of frequent order of small quantities.
2. Target Costing
Target costing refers to the design of product, and the processes used to produce it, so that ultimately the product can be manufactured at a cost that will enable the firm to make profit when the product is sold at an estimated market-driven price. This estimated price is called target price.
3.Activity Based Management(ABM)
Activity based management is the use of activity based costing to improve operations and to eliminate non-value added cost. The main goal of ABM is to identify and eliminate non-value added activities and costs.
4.Life Cycle Costing
Life cycle costing estimates and accumulates costs over a product's entire life cycle in order to determine whether the profits earned during the manufacturing phase will cover the costs incurred during the pre-and-post manufacturing stage.
5. Kaizen Costing
Kaizen costing is the process of cost reduction during the manufacturing phase of an existing product. The Japanese word 'Kaizen' refers to continual and gradual improvement through small activities, rather than large or radical improvement through innovation or large investment technology.
6.Business Precess-re-engineering
Re-engineering is a complete redesign of process with an emphasis on finding creative new ways to accomplish an objective.The aim of business process re-engineering is to improve the key business process in an organization by focusing on simplification, cost reduction, improved quality and enhanced customer satisfaction.
7.Total Quality Management(TQM)
Under the TQM approach, all business functions are involved in a process of continuous quality improvement.
8. Value chain
Value chain analysis is a means of achieving higher customer satisfaction and managing costs more effectively. The value chain is the linked set of value creating activities all the way from basic raw materials' sources, component suppliers, to the ultimate end-use product or service delivered to the customer.
9. Bench Marketing
Bench marketing is a continual search for the most effective method of accomplishing a task by comparing the existing methods and performance levels with those of other organizations or other sub-units within the same organization.
10. Management Audits
Management audits, also known as performance audits, can be used to facilitate cost reduction in both profit and non-profit organizations. Management audits are intended to help management to do a better job by identifying waste and inefficiency and recommending a corrective action.
1. Just-In-Time (JIT) System
The main aim of JIT is to produce the required items, at the required quality and quantity, at the precise time they are required. JIT purchasing requires for the items where too much carrying costs associated with holding high inventory levels. purchasing system reduces the investment in inventories because of frequent order of small quantities.
2. Target Costing
Target costing refers to the design of product, and the processes used to produce it, so that ultimately the product can be manufactured at a cost that will enable the firm to make profit when the product is sold at an estimated market-driven price. This estimated price is called target price.
3.Activity Based Management(ABM)
Activity based management is the use of activity based costing to improve operations and to eliminate non-value added cost. The main goal of ABM is to identify and eliminate non-value added activities and costs.
4.Life Cycle Costing
Life cycle costing estimates and accumulates costs over a product's entire life cycle in order to determine whether the profits earned during the manufacturing phase will cover the costs incurred during the pre-and-post manufacturing stage.
5. Kaizen Costing
Kaizen costing is the process of cost reduction during the manufacturing phase of an existing product. The Japanese word 'Kaizen' refers to continual and gradual improvement through small activities, rather than large or radical improvement through innovation or large investment technology.
6.Business Precess-re-engineering
Re-engineering is a complete redesign of process with an emphasis on finding creative new ways to accomplish an objective.The aim of business process re-engineering is to improve the key business process in an organization by focusing on simplification, cost reduction, improved quality and enhanced customer satisfaction.
7.Total Quality Management(TQM)
Under the TQM approach, all business functions are involved in a process of continuous quality improvement.
8. Value chain
Value chain analysis is a means of achieving higher customer satisfaction and managing costs more effectively. The value chain is the linked set of value creating activities all the way from basic raw materials' sources, component suppliers, to the ultimate end-use product or service delivered to the customer.
9. Bench Marketing
Bench marketing is a continual search for the most effective method of accomplishing a task by comparing the existing methods and performance levels with those of other organizations or other sub-units within the same organization.
10. Management Audits
Management audits, also known as performance audits, can be used to facilitate cost reduction in both profit and non-profit organizations. Management audits are intended to help management to do a better job by identifying waste and inefficiency and recommending a corrective action.
Cost Reduction Areas
One of the main responsibility of a management is to find out the areas in which the excess costs may be reduced. Following are the main cost reduction areas:
1. Product Improvement
* Quality of a product
* Wastage minimization
* Proper designing of a product
2. Production Method And Layout Management
* Material handling system
* Layout management
* Time and motion study
* Standardization
* Modernization of plants and equipments
3. Marketing Areas
* Distribution channels
* Advertisement media
* Promotional Schemes
* Packing styles
* Transportation arrangement
4. Administrative And Financial Areas
* Purchase of supplies
* Reward punishment system
* Accounting system
* Financing alternatives
1. Product Improvement
* Quality of a product
* Wastage minimization
* Proper designing of a product
2. Production Method And Layout Management
* Material handling system
* Layout management
* Time and motion study
* Standardization
* Modernization of plants and equipments
3. Marketing Areas
* Distribution channels
* Advertisement media
* Promotional Schemes
* Packing styles
* Transportation arrangement
4. Administrative And Financial Areas
* Purchase of supplies
* Reward punishment system
* Accounting system
* Financing alternatives
Differences Between Cost Control And Cost Reduction
Following are the main differences between cost control and cost reduction:
1. Focus
Cost control focuses on the minimization of wastage than the reduction of cost. Cost reduction focuses on minimization of cost through new production process, improved plant layout, scientific material handling etc.
2. Basis Of Application
Cost control is routinely applied on a continuous basis. Cost reduction is applied when an opportunity for cost reduction is identified which offers a competitive advantage for a longer time.
3. Use Of Accounting Techniques
Cost control heavily relies on accounting techniques. Cost reduction may not involve the use of accounting technique.
1. Focus
Cost control focuses on the minimization of wastage than the reduction of cost. Cost reduction focuses on minimization of cost through new production process, improved plant layout, scientific material handling etc.
2. Basis Of Application
Cost control is routinely applied on a continuous basis. Cost reduction is applied when an opportunity for cost reduction is identified which offers a competitive advantage for a longer time.
3. Use Of Accounting Techniques
Cost control heavily relies on accounting techniques. Cost reduction may not involve the use of accounting technique.
Concept And Meaning Of Cost Reduction
Cost reduction means conducting some innovations in the way of working in a new style, so that the excess costs of production and operation could be eliminated. Cost reduction programs are directed toward specific efforts to reduce costs by improving methods work arrangements and products. Cost reduction can be made in different areas and stages of production, storing and distribution process by applying more advanced and scientific techniques of operation. So, a cost reduction program needs a research and development activity.
Cost reduction programs may require a bulk amount of research and development budget, but once a new technique is introduced, it gives competitive advantages for the long period.
The aim of cost reduction is to see whether there is any possibility of bringing about a saving in the costs incurred on materials, labor, overheads etc.
Cost reduction is possible through the following improvements:
* Obtaining more outputs from the same inputs and facilities.
* Using a lesser quantity of inputs to obtain the same output .
* Simplifying the methods of distribution.
* Improving the location and layout of plant, warehouse and other resources.
Cost reduction programs may require a bulk amount of research and development budget, but once a new technique is introduced, it gives competitive advantages for the long period.
The aim of cost reduction is to see whether there is any possibility of bringing about a saving in the costs incurred on materials, labor, overheads etc.
Cost reduction is possible through the following improvements:
* Obtaining more outputs from the same inputs and facilities.
* Using a lesser quantity of inputs to obtain the same output .
* Simplifying the methods of distribution.
* Improving the location and layout of plant, warehouse and other resources.
Concept And Meaning Of Cost Control
Cost Control
Control is function that make sure that actual work is done to fulfill the original intention. It is a widely accepted notion that the actual costs for each cost element should be within the budget. Like hospitality and entertainment, expenses in a marketing department should not exceed the budget allowed for that head for the given period. Cost control is thought of as a managerial effort to attain cost goals within a particular environment.
Cost control is not a specific program. Rather, it is a routine activity to be frequently carried out. Cost must be controlled, otherwise, there will be wastage, misappropriation and embezzlement. Checking such wastage and misappropriation of resources is a continuous activity. A firm exercising a better control last year does not mean that it has now been relaxed from the cost control function. Cost control relies heavily on accounting techniques. Some of the key cost control techniques are responsibility accounting control system, standard costing, budgetary control and cost management ratios.
Therefore, cost control includes the routine management of the organizational activities, such as controlling of wastage, misappropriation, loss of work time, set up time etc.
Control is function that make sure that actual work is done to fulfill the original intention. It is a widely accepted notion that the actual costs for each cost element should be within the budget. Like hospitality and entertainment, expenses in a marketing department should not exceed the budget allowed for that head for the given period. Cost control is thought of as a managerial effort to attain cost goals within a particular environment.
Cost control is not a specific program. Rather, it is a routine activity to be frequently carried out. Cost must be controlled, otherwise, there will be wastage, misappropriation and embezzlement. Checking such wastage and misappropriation of resources is a continuous activity. A firm exercising a better control last year does not mean that it has now been relaxed from the cost control function. Cost control relies heavily on accounting techniques. Some of the key cost control techniques are responsibility accounting control system, standard costing, budgetary control and cost management ratios.
Therefore, cost control includes the routine management of the organizational activities, such as controlling of wastage, misappropriation, loss of work time, set up time etc.
Limitations Or Disadvantages Of Budgeting
Following are the main limitations or disadvantages of budgeting:
* It is difficult, if not impossible, to estimate revenues and expenses in a business enterprise realistically.
* It is not realistic to write out and distribute a company's goals, policies and guidelines to all the supervisors.
* Budgeting places too great a demand of time on management, especially to revise budgets constantly. Too much paper work is required for budgeting.
* Budgeting takes away management flexibility.
* Budgeting creates a lot of behavioral problems.
* Budgeting adds a level of complexity that is not needed.
* Budgeting is too costly, aside from the management of time.
* The managers, supervisors and other employees hesitate with budgeting.
* It is difficult, if not impossible, to estimate revenues and expenses in a business enterprise realistically.
* It is not realistic to write out and distribute a company's goals, policies and guidelines to all the supervisors.
* Budgeting places too great a demand of time on management, especially to revise budgets constantly. Too much paper work is required for budgeting.
* Budgeting takes away management flexibility.
* Budgeting creates a lot of behavioral problems.
* Budgeting adds a level of complexity that is not needed.
* Budgeting is too costly, aside from the management of time.
* The managers, supervisors and other employees hesitate with budgeting.
Advantages Of Budgeting
The following main arguments are usually given for budgeting or following are the main advantages of budgeting.
* Budgeting forces early consideration of basic polices.
* It requires an adequate and sound organizational structure, that is , there must be a definite assignment of responsibility for each function of the enterprise.
* Budgeting compels all the members of management, from the top to bottom to participate in the establishment of goals and plans.
* Budgeting compels departmental managers to make plans in harmony with the other departments and of the entire enterprise.
* Budgeting helps the management to put down in figures what is necessary for a satisfactory performance.
* Budgeting helps the management to plan for the most economical use of labor, material and capital.
* Budgeting tends to remove the cloud of uncertainty that exists in many organizations, especially among lower levels of management, relative to basic policies and objectives.
* Budgeting promotes an understanding among members of management of their co-workers' problems.
* Budgeting force management to give adequate attention to the effects of general business conditions.
* Budgeting aids in obtaining bank credit as banks commonly require a projection of future operations and cash flows to support loans.
* Budgeting checks progress towards the objectives of the enterprise.
* Budgeting rewards high performance and seeks to correct unfavorable performance.
* Budgeting forces management to consider expected future trends and conditions.
* Budgeting forces early consideration of basic polices.
* It requires an adequate and sound organizational structure, that is , there must be a definite assignment of responsibility for each function of the enterprise.
* Budgeting compels all the members of management, from the top to bottom to participate in the establishment of goals and plans.
* Budgeting compels departmental managers to make plans in harmony with the other departments and of the entire enterprise.
* Budgeting helps the management to put down in figures what is necessary for a satisfactory performance.
* Budgeting helps the management to plan for the most economical use of labor, material and capital.
* Budgeting tends to remove the cloud of uncertainty that exists in many organizations, especially among lower levels of management, relative to basic policies and objectives.
* Budgeting promotes an understanding among members of management of their co-workers' problems.
* Budgeting force management to give adequate attention to the effects of general business conditions.
* Budgeting aids in obtaining bank credit as banks commonly require a projection of future operations and cash flows to support loans.
* Budgeting checks progress towards the objectives of the enterprise.
* Budgeting rewards high performance and seeks to correct unfavorable performance.
* Budgeting forces management to consider expected future trends and conditions.
Objectives Of A Budget
The main objective of a firm is to make an excess of revenue over expenses to maximize profit. But it is not a matter of a dream or chance. There is no magic formula for boosting the figure of profit overnight. Budgeting can increase the chances of making profits within the given environment.
The main objectives of budgets are as follows:
* To provide a realistic estimate of income and expenses for a period and of the financial position at the close of the period.
* To provide a coordinated plan of action which is design to achieve the estimates reflected in the budget.
* To provide a comparison of actual results with those budgeted and an analysis and interpretation of deviations by areas of responsibility to indicate courses of corrective actions and to lead to improvement in future plans.
* To provide a guide for management decisions in adjusting plans and objectives if there is an uncontrollable change in conditions.
* To provide a ready basis for making forecasts during the budget period to guide management in making day to day decisions.
The main objectives of budgets are as follows:
* To provide a realistic estimate of income and expenses for a period and of the financial position at the close of the period.
* To provide a coordinated plan of action which is design to achieve the estimates reflected in the budget.
* To provide a comparison of actual results with those budgeted and an analysis and interpretation of deviations by areas of responsibility to indicate courses of corrective actions and to lead to improvement in future plans.
* To provide a guide for management decisions in adjusting plans and objectives if there is an uncontrollable change in conditions.
* To provide a ready basis for making forecasts during the budget period to guide management in making day to day decisions.
Outline Of The Components Of Budgeting Or Budgeting Plan
Strategic Plan
a) Setting broad objectives of the enterprise
b) Defining specific enterprise goals
c) Formulating enterprise strategies
d) Circulating management's planning instructions
Financial Plan
a) Long-term financial plan
* Sales, costs and profit projections
* Major projects and capital additions
* Cash flow and financing
* Personnel requirements
b) Short term annual budgets
* preparing operating budgets like sales budget, production budget, material and purchase budget, labor budget, manufacturing overhead budget, administrative expense budget, and distribution expense budget.
* Preparing financial position budgets like proforma income statement, proforma balance sheet, cash flow plan, performance reports, and follow-up, corrective action and re-planning report.
a) Setting broad objectives of the enterprise
b) Defining specific enterprise goals
c) Formulating enterprise strategies
d) Circulating management's planning instructions
Financial Plan
a) Long-term financial plan
* Sales, costs and profit projections
* Major projects and capital additions
* Cash flow and financing
* Personnel requirements
b) Short term annual budgets
* preparing operating budgets like sales budget, production budget, material and purchase budget, labor budget, manufacturing overhead budget, administrative expense budget, and distribution expense budget.
* Preparing financial position budgets like proforma income statement, proforma balance sheet, cash flow plan, performance reports, and follow-up, corrective action and re-planning report.
Meaning Of Budgeting And Budget
Budgeting
Profit is the primary measure of business success. Usually, profits do not just happen. Profits are managed. Therefore, the profitability the firm fully depends on as to what extent the management follows proper planning, effective co-ordination and dynamic control. This requires that management must plan for the future financial and physical requirements for maintaining productivity and profitability of the firm is generally called 'budgeting'.
Budgeting is a tool of planning and control. Budgeting involves the steps of setting short-term objectives, specifying programs, and expressing them in the budgets. Budgeting includes sales, production, distribution and financial aspects aspects the firm.
Budget
A budget is a comprehensive and coordinated plan, expressed in financial terms, for the operations and resources of the firm for some specified period in the future. Budget programs are designed to carry out a variety of functions like, planning activities, implementing plans, communicating, motivating and authorizing actions.
A budget is a written plan for the future. A complete budget for a firm is often called the master budget.
Therefore, a budget is a numerical plan of action that must be prepared in advance of commencing operations, stating what and how things are to be done. It covers a definite period of time, usually one year. The budget is basically forecasted financial statement, which expresses managerial plans that include all phases of operations such as sales, production, purchasing, manpower and financing.
Profit is the primary measure of business success. Usually, profits do not just happen. Profits are managed. Therefore, the profitability the firm fully depends on as to what extent the management follows proper planning, effective co-ordination and dynamic control. This requires that management must plan for the future financial and physical requirements for maintaining productivity and profitability of the firm is generally called 'budgeting'.
Budgeting is a tool of planning and control. Budgeting involves the steps of setting short-term objectives, specifying programs, and expressing them in the budgets. Budgeting includes sales, production, distribution and financial aspects aspects the firm.
Budget
A budget is a comprehensive and coordinated plan, expressed in financial terms, for the operations and resources of the firm for some specified period in the future. Budget programs are designed to carry out a variety of functions like, planning activities, implementing plans, communicating, motivating and authorizing actions.
A budget is a written plan for the future. A complete budget for a firm is often called the master budget.
Therefore, a budget is a numerical plan of action that must be prepared in advance of commencing operations, stating what and how things are to be done. It covers a definite period of time, usually one year. The budget is basically forecasted financial statement, which expresses managerial plans that include all phases of operations such as sales, production, purchasing, manpower and financing.
Classification Or Types Of Overhead Variances
1. Capacity Or Volume Variance
The overhead volume variance is a deviation of the actual from the budgeted over expenses. Generally, the capacity or volume variance denote the deviation from the budgeted fixed overheads of the fixed overheads applied to the product. It is denoted as a volume variance because it can be calculated for variable as well as fixed overheads into a single rate based on the same activity.
2. Spending Variance
Spending variance is the difference between the actual overheads incurred and the flexible budget overheads for the actual volume. This variance arises due to the deviation of the actual overheads from the flexible budget overheads for the actual volume.
3. Efficiency Variance
The overhead efficiency variance is the difference between the actual and standard hours of an activity.In other words, it is the difference between the actual output and standard output multiplied by the variable overhead rate.
The overhead volume variance is a deviation of the actual from the budgeted over expenses. Generally, the capacity or volume variance denote the deviation from the budgeted fixed overheads of the fixed overheads applied to the product. It is denoted as a volume variance because it can be calculated for variable as well as fixed overheads into a single rate based on the same activity.
2. Spending Variance
Spending variance is the difference between the actual overheads incurred and the flexible budget overheads for the actual volume. This variance arises due to the deviation of the actual overheads from the flexible budget overheads for the actual volume.
3. Efficiency Variance
The overhead efficiency variance is the difference between the actual and standard hours of an activity.In other words, it is the difference between the actual output and standard output multiplied by the variable overhead rate.
Concept Of Overheads And Overhead Variance
Overheads
Besides prime costs, other indirect expenses may be incurred in the process of production or providing services, such expenses are denoted by a broad term i.e. overhead expenses. All the indirect expenses incurred in order to bring the goods to salable condition are termed as 'overheads' or 'supplementary costs.
Overhead Variance
The overhead variance is the deviation from the standard costs of overhead allowed for the actual output achieved and actual overhead costs incurred. With a view to conveying the useful information to control the overhead expenses, overhead variances can be classified as follows:
* Capacity or Volume variance
* Spending variance
* Efficiency variance
Besides prime costs, other indirect expenses may be incurred in the process of production or providing services, such expenses are denoted by a broad term i.e. overhead expenses. All the indirect expenses incurred in order to bring the goods to salable condition are termed as 'overheads' or 'supplementary costs.
Overhead Variance
The overhead variance is the deviation from the standard costs of overhead allowed for the actual output achieved and actual overhead costs incurred. With a view to conveying the useful information to control the overhead expenses, overhead variances can be classified as follows:
* Capacity or Volume variance
* Spending variance
* Efficiency variance
Preparation Of Flexible Budget Using Formula Approach
Preparing a budget is an art. The formats of budgeting are neither predetermined nor rigid. They vary with the nature of data, size of transactions, and the person who develops the formats. However, whatever may be the type of format, it should be neat, clean, and self-explanatory.
Formula Approach Of Flexible Budget
This approach provides a formula for each expense account in each responsibility center. The formula gives the fixed amount and the variable rate, i.e., per unit rate. This approach is widely use in actual practice. Under this approach, a formula is used to express the straight-line relationship between total overhead costs and fixed amount and the variable rate to be multiplied by the output level i.e. labor hours, machine hours or units produced. Cost factors for flexible budgeting purposes can be developed as follows:
Budget Allowance = Total fixed Costs + (Unit variable costs x Units)
Symbolically, BA = FC + (UVC x Q)
Where, Q = Output level i.e. labor hours, machine hours or units produced
Formula Approach Of Flexible Budget
This approach provides a formula for each expense account in each responsibility center. The formula gives the fixed amount and the variable rate, i.e., per unit rate. This approach is widely use in actual practice. Under this approach, a formula is used to express the straight-line relationship between total overhead costs and fixed amount and the variable rate to be multiplied by the output level i.e. labor hours, machine hours or units produced. Cost factors for flexible budgeting purposes can be developed as follows:
Budget Allowance = Total fixed Costs + (Unit variable costs x Units)
Symbolically, BA = FC + (UVC x Q)
Where, Q = Output level i.e. labor hours, machine hours or units produced
Differences Between Static Budget And Flexible Budget
Following are the main differences between static and flexible budget:
1. Nature
A static budget does not change with the actual volume of the output achieved. A flexible budget is designed to change appropriately with the level of activity attained.
2. Scope
A static budget cannot ascertain costs correctly in case of any change in circumstances. Flexible budget can easily ascertain costs in different levels of activities.
3. Determination Of Cost
Static budget is prepared under the assumption that all conditions will remain unaltered. Flexible budget is prepared at different levels of activities considering the possible changes in the operational aspect of a business.
4. Assumptions
Static budget has a limited application and is ineffective as a tool for cost control. Flexible budget has a wide application as an effective tool for cost control.
5. Pre-requistes
Static budget is prepared without classifying the costs according to their variable nature. Flexible budget is prepared by classifying the costs according to their variable nature.
1. Nature
A static budget does not change with the actual volume of the output achieved. A flexible budget is designed to change appropriately with the level of activity attained.
2. Scope
A static budget cannot ascertain costs correctly in case of any change in circumstances. Flexible budget can easily ascertain costs in different levels of activities.
3. Determination Of Cost
Static budget is prepared under the assumption that all conditions will remain unaltered. Flexible budget is prepared at different levels of activities considering the possible changes in the operational aspect of a business.
4. Assumptions
Static budget has a limited application and is ineffective as a tool for cost control. Flexible budget has a wide application as an effective tool for cost control.
5. Pre-requistes
Static budget is prepared without classifying the costs according to their variable nature. Flexible budget is prepared by classifying the costs according to their variable nature.
Importance Or Advantages Of Flexible Budget
The usefulness or importance of a flexible budget depends very much on the accuracy of the classification of expenses into fixed, semi-fixed and variable ones. The important advantages of flexible budget are as follows:
* A flexible budget enables the management to analyze the deviation of actual output from expected output.
* The management can compare actual costs at the actual volume with the budgeted costs at the actual volume.
* The flexible budget provides a correct basis for comparison between actual and expected costs for an actual activity.
* Flexible budget helps to fulfill the objectives of cost control as it shows where the actual performance deviated from the planned performance.
* A flexible budget enables the management to analyze the deviation of actual output from expected output.
* The management can compare actual costs at the actual volume with the budgeted costs at the actual volume.
* The flexible budget provides a correct basis for comparison between actual and expected costs for an actual activity.
* Flexible budget helps to fulfill the objectives of cost control as it shows where the actual performance deviated from the planned performance.
Characteristics Of Flexible Budget And Steps To Be Followed For Preparing A Flexible Budget
The important characteristics of flexible budget can be pointed as follows:
* Flexible budget covers a range of activities
* Flexible budget is easy to change according to variations of production and sales levels.
* Flexible budget facilitates performance measurement and evaluation.
* It takes into account the changes in the volume of activity.
* Flexible budget replaces a static budget for control.
Steps To Be Followed For Preparing A Flexible Budget:
* To decide the range of activities for which the budget is to be prepared.
* To determine the cost behavior i.e. fixed, variable or semi-variable.
* To select the activity level for preparing the budget.
* To prepare flexible budget at each selected levels.
* Flexible budget covers a range of activities
* Flexible budget is easy to change according to variations of production and sales levels.
* Flexible budget facilitates performance measurement and evaluation.
* It takes into account the changes in the volume of activity.
* Flexible budget replaces a static budget for control.
Steps To Be Followed For Preparing A Flexible Budget:
* To decide the range of activities for which the budget is to be prepared.
* To determine the cost behavior i.e. fixed, variable or semi-variable.
* To select the activity level for preparing the budget.
* To prepare flexible budget at each selected levels.
Concept And Meaning Of Flexible Budget
Usually, a firm prepares a budget for a single expected level of activity such as production or sale. It does not change the budget even if the level of activity differs from the expected. Such a budget is called static or fixed budget. Since the actual level of activity may significantly differ from the expected, the static budget has limited use for cost control purpose. Besides, it also fails to analyze the reasons for the difference between the actual and expected levels of activity. It also causes difficulty in forecasting the operation for the firms dealing in continuous and job order production. Therefore, another type of budgeting was developed to overcome the limitations of static budget, which is known as flexible budgeting. The flexible budgeting can cope with the changing business situation of the firm.
A flexible budget is a set of alternative budgets for different expected levels of activities i.e. production and sales on the basis of a cost-volume-profit relationship, that requires an intelligent classification of all expenses into fixed or semi-fixed, variable or semi-variable. It is a restatement of the master budget for the achieved level of activities. The flexible budget is also called a variable budget, which shows the budgeted revenue, costs and profits for different levels of business activities rather than being based on only one level of activity. Thus, flexible budget can be used to evaluate the efficiency of a department throughout the business even if the actual level of business activity differs from the management's original estimates.
Therefore, flexible budget is a kind of budget, which recognizes the variability of costs and incorporates any change in levels of activities by preparing budgets for different levels of activity.
A flexible budget is a set of alternative budgets for different expected levels of activities i.e. production and sales on the basis of a cost-volume-profit relationship, that requires an intelligent classification of all expenses into fixed or semi-fixed, variable or semi-variable. It is a restatement of the master budget for the achieved level of activities. The flexible budget is also called a variable budget, which shows the budgeted revenue, costs and profits for different levels of business activities rather than being based on only one level of activity. Thus, flexible budget can be used to evaluate the efficiency of a department throughout the business even if the actual level of business activity differs from the management's original estimates.
Therefore, flexible budget is a kind of budget, which recognizes the variability of costs and incorporates any change in levels of activities by preparing budgets for different levels of activity.
Concept And Formula Of Labor Idle Time Variance(LITV)
Labor idle time variance, which is also known as sub-efficiency variance, indicates the standard cost of the actual hours for which the employees may remain idle due to abnormal circumstances like strikes, lockouts, power failure, breakdown of machinery, unavailability of raw materials, transportation strike, and so on. The idle time variance is always unfavorable. For the accurate calculation of the labor efficiency variance, labor idle time should be adjusted.
Formula For The Calculation Of Labor Idle Time Variance (LITV)
Labor Idle Time Variance (LITV) = Idle Time x Standard Rate
Formula For The Calculation Of Labor Idle Time Variance (LITV)
Labor Idle Time Variance (LITV) = Idle Time x Standard Rate
Concept And Formula Of Labor Yield Variance(LYV)
The labor yield variance is one of the components of labor efficiency variance, which results from the difference between actual output of worker and standard output of worker specified. Labor yield variance can be obtained from the difference between the labor mix variance and labor idle time variance.
Formula for the calculation of labor yield variance (LYV)
LYV = (AY - SY) x SC
Where,
AY = Actual yield or output
SY = Standard Yield or output for actual input
SC = Standard cost per unit
If the resulting figure is positive it is denoted as favorable variance and if the resulting figure is negative, it is denoted as unfavorable variance.
Formula for the calculation of labor yield variance (LYV)
LYV = (AY - SY) x SC
Where,
AY = Actual yield or output
SY = Standard Yield or output for actual input
SC = Standard cost per unit
If the resulting figure is positive it is denoted as favorable variance and if the resulting figure is negative, it is denoted as unfavorable variance.
Concept And Formula Of Labor Mix Or Gang Composition Variance
The term gang represents the composition of more than one grade workers/employees. This composition may differ in between the standard and the actual. Hence, the labor mix or gang composition variance occurs due to the difference between standard labor grades specified and actual labor grades utilized.
Formula For The Calculation Of Labor Mix Variance(LMV)
LMV = SR x (RST - AT)
Where,
LMV = Labor mix variance
SR = Standard Rate
RST = Revised standard time
AT = Actual time
NOTE:
RST = (Total time of actual mix/Total time of standard mix) x Standard time of each grade of employees.
If the resulting figure is positive, it is denoted as favorable and if the resulting figure is negative, it is denoted as unfavorable variance.
Formula For The Calculation Of Labor Mix Variance(LMV)
LMV = SR x (RST - AT)
Where,
LMV = Labor mix variance
SR = Standard Rate
RST = Revised standard time
AT = Actual time
NOTE:
RST = (Total time of actual mix/Total time of standard mix) x Standard time of each grade of employees.
If the resulting figure is positive, it is denoted as favorable and if the resulting figure is negative, it is denoted as unfavorable variance.
Concept And Formula Of Labor Efficiency Variance
Direct labor efficiency variance is the difference between the labor hours specified for the activity achieved and the actual labor hours expected for a predetermined level of output. It is also called time variance, which is the result of taking more or less time than the standard time specified for the performance of the work.
Formula For The Calculation Of Labor Efficiency Variance (LEV)
LEV = SR x (ST-AT)
Where,
LEV = Labor efficiency variance
SR = Standard rate
ST = Standard time
AT = Actual time
OR, LEV = LMV+LYV+LITV
Where,
LMV = Labor mix variance
LYV = Labor yield variance
LITV = Labor idle time variance
If the actual time is less than the standard time, there will be favorable variance and if actual time is more than standard time, there will be unfavorable variance.
Formula For The Calculation Of Labor Efficiency Variance (LEV)
LEV = SR x (ST-AT)
Where,
LEV = Labor efficiency variance
SR = Standard rate
ST = Standard time
AT = Actual time
OR, LEV = LMV+LYV+LITV
Where,
LMV = Labor mix variance
LYV = Labor yield variance
LITV = Labor idle time variance
If the actual time is less than the standard time, there will be favorable variance and if actual time is more than standard time, there will be unfavorable variance.
Concept And Formula Of Labor Rate Variance (LRV)
Direct labor rate variance is the difference between the standard rate of wages specified and the actual rate of wages paid. Labor rate variance is that portion of direct labor variance, which occurs due to the difference between standard rate of pay specified and actual rate paid.
Formula For The Calculation Of Labor Rate Variance (LRV)
Labor Rate Variance (LRV) = AT x (SR-AR)
Where,
AT = Actual Time
SR = Standard Rate
AR = Actual rate
If the actual rate is more than the standard rate, there will be an adverse or unfavorable variance and when the actual rate is less than the standard rate, the variance will be favorable.
Formula For The Calculation Of Labor Rate Variance (LRV)
Labor Rate Variance (LRV) = AT x (SR-AR)
Where,
AT = Actual Time
SR = Standard Rate
AR = Actual rate
If the actual rate is more than the standard rate, there will be an adverse or unfavorable variance and when the actual rate is less than the standard rate, the variance will be favorable.
Concept And Formula Of Labor Cost Variance (LCV)
Direct labor cost variance is the difference between the standard direct labor cost for the actual output and the actual labor cost paid. Labor cost variance can be defined as the deviation of the actual direct wages paid from the direct wages specified for the standard output.
Formula for calculation of labor cost variance (LCV)
LCV = (ST x SR) - ( AT x AR)
Where,
LCV = Labor cost variance
ST = Standard time
SR = Standard rate
AT = Actual time
AR = Actual rate
Labor cost variance represents the total of the labor rate variance and the labor efficiency variance.
Therefore, LCV = Labor rate variance (LRV) + Labor efficiency variance LEV)
If the resulting figure is positive, the difference is denoted by F i.e. favorable variance and if the resulting figure is negative, the difference is denoted by U i.e. unfavorable variance.
Formula for calculation of labor cost variance (LCV)
LCV = (ST x SR) - ( AT x AR)
Where,
LCV = Labor cost variance
ST = Standard time
SR = Standard rate
AT = Actual time
AR = Actual rate
Labor cost variance represents the total of the labor rate variance and the labor efficiency variance.
Therefore, LCV = Labor rate variance (LRV) + Labor efficiency variance LEV)
If the resulting figure is positive, the difference is denoted by F i.e. favorable variance and if the resulting figure is negative, the difference is denoted by U i.e. unfavorable variance.
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